Multifamily Investments Don’t Make Sense Right Now with Ken McElroy

Why a legend in the
real estate business is not buying
multifamilies right now and sees real value in
residential real estate– that’s today’s episode. Let’s dive into it. [WHOOSH] Hey, everyone. I’m Clayton Morris, longtime
real estate investor. And this is the show, if
you’re new to the show, where we talk about building
financial freedom– passive income. And the vehicle that we use
is buy-and-hold real estate. It’s been the thing
that has enabled me to achieve financial freedom. And we hope for many
of you the same thing. But I don’t care
exactly what you buy. You could buy bitcoin. You could buy gold. You could buy anything. But you may want to avoid
buying multifamilies right now because just the
returns might not be there. My guest today on the show– I’m thrilled to have
him back on the show. Good friend, and we’ve become
friends over the years. And one of the legends in
the real estate business, and the author of the book The
ABCs of Real Estate Investing. If you haven’t read
that book, it’s like one the gold standards for
real estate investing books. You’ve got to check it out. We’ll have a link below. It’s Ken McElroy. Ken, welcome back to the show. Great to see you. Clayton, great to be on. Thanks a lot. I can’t wait to dive
into our topic today. Yeah, absolutely. And we’re enjoying
our summer here. We’re both kind of on the road. So we’re sort of
fish out of water right now, out of
our normal studios. But I’m glad we could
finally connect. We were going to try to
connect like two months ago, then you were traveling,
then I was traveling. Yeah. So busy, busy man as
real estate investors. But glad to have you back, man. Thank you. Thank you. I can’t wait. So when I saw you last,
we were having lunch together a few months ago. And one of the topics
we were talking about is the current
state of the market. Now, as in fact,
Robert Kiyosaki– when we were in
the room together, Robert had you get up and talk
about sort of the current state of the market. You’re the real estate advisor
for the Rich Dad Company and Robert’s go-to guy
on real estate investing. (CHUCKLING) When he wants to
put his money in real estate, he calls you. And one of the things
you said right now, you’re known as like
the multifamily guy. I mean, that’s what you buy. You buy big, big projects,
couple hundred unit apartments and condos and town
home developments. But right now, you said
something interesting. What did you tell me about the
current state of multifamily? Well, really what’s
happening is, oddly enough, it’s still a
very good time to own property. But it’s a very, very
hard time to buy it because of all the hot
money coming into the market right now. So when I say “hot money,” I
mean like people’s pensions and insurance money
and private equity and institutional equity,
you know, Wall Street. That money is really
driving prices up. And so guys like me– and
even though I own 10 thousand apartments– I’m a small player really. I’m a small, regional player
even though we have $1 billion worth of real estate. The guys that we’re
bidding against are guys that have $100 million
to $500 million dollar funds and are driving
prices up right now. So prices are going
up considerably. And where do you see, then– so you told me an
interesting story. You said, I can’t believe
some of these guys are snapping up properties. And we talk about return
on investment, right. So let’s just talk about ROI
and return on investment. What do you usually look for? When you’re picking up
apartment complexes, when you’re picking up large
multifamilies, what are you looking
for from a return on investment standpoint? What meets your criteria? Yeah, so that’s probably
the best question because my criteria and
Wall Street’s criteria are very different. So they’re trying
to preserve capital. They’re trying to take people’s
money and put it into work. I’m actually trying
to produce a return to an investor, much like you. You know, I sit across the
table from these people. I get their hard-earned
money, and I want to produce a return for them. And it’s usually
significantly higher than, say, something
that Wall Street’s doing. So my general goal is to
do anywhere between a 7% and a 10% cash-on-cash return. That’s generally
what I’m trying to do as I’m analyzing a property
and trying to buy a property. I’m always trying to
solve to that number. And occasionally
I’ll stretch and buy something maybe
that’s broken, maybe it has a high vacancy or
something that I can fix. And it might have
significantly less. But I can manage it and
turn it around and turn it into something more profitable. But that’s generally
what I’d shoot for. So 7% to 10%. And right now, you
were telling me that, wow, I’m seeing
people that are snapping up properties at what return? What numbers are they even
going after right now? Well, so what happens is, the
great thing about real estate is it’s really slow. And it’s not like
a stock, where you have to act on it immediately. And so we had an
acquisition team– guys that would go out
and find properties all over the country. And we were meeting with
lots of different brokers in lots of different cities. And we probably analyzed over
600 properties last year. Wow. And we made between
50 and 60 offers. And so there a big
process to this. And so the point
of that story is, we lost out on every
single deal, except one. So we bought one
deal out of 600. Out of analyzing 600-plus
deals and offering somewhere in the 50s, we
ended up with one. And the interesting thing
is, Clayton, as you know, I know what the numbers are. So I know what the rents are. I know what the expenses are. And I actually even
know what it sells for. And we were getting bid out
by $1 million to $2 million per deal. So I could take that number
and back into the return. You know what I mean? Right. Because I’m intimately
aware of the numbers. And so it’s easy for
me to figure out, OK, we lost that deal. So who was the buyer? And how much did they pay? And what’s their
return going to be? And so we went
through that process so much that we just
realized there’s no way we can stretch to– a 2%, 3% return is what some
of these deals were trading at. Wow. And we just didn’t want to. So that’s when we let
our acquisition guy go. And we said, hey, we’re not
going to play at this point. But you were saying that,
while you guys wouldn’t play at that low return– 2% to 3%– I mean, there’s a lot of other
people that are, (CHUCKLING) right. Yeah, well, that’s interesting. You’ve got to look at
their motivation, OK. And it’s good to
get a little edgy. But if you think about
it, if you put money into a life policy
or a pension policy or let’s say a
private equity group, there’s pressure on that
group to place that money because it’s making zero. And there’s real costs
for that fund, as well. And so their motivation is much
different than mine or yours. I’m actually
investing my own money and my investors’ money,
where they don’t even see the face of the people. And so they’re placing
big chunks of capital all over the place. And so their motivations
are significantly different. The other piece that you’re
going to see right now is, you’re going to see
these syndicators out there standing on a stage,
raising a bunch of money. And you’ve got to look
at their motivation. Are they making money
from their seminars? And are they making money
from their syndication fees? And so you’ve got
to look at that. And I’m not saying they’re
doing anything wrong. I’m just saying that you have to
look at somebody’s motivation. Why are they doing it? You know, the guys
on Wall Street, they’re doing it so
they can pay their rent. And the same thing
with the syndicators. They don’t have a legacy
of a lot of cash flow and a lot of property like we
do, where we can step back. We have over $1 million of
free cash flow every month coming in on our projects, so
we don’t have to do any deals. Whereas if you’re
starting out and you’re trying to pay your
rent and you’re trying to grow a business or
a brand, it’s a lot different. When you look at
those properties that you’re going
in for 7% to 10%, and you’re backing out
some of those numbers, the value-add that
you’re looking to put into those properties–
what is your checklist that you go down, that you
say, OK, if I pick it for this, I know that the value add I
can bring to this property will give me this? What is that checklist
of value-add items? Yeah. And first of all, define
“value-add” for us– what that looks like to you. And then what are the items
that you try to click off of to really add more cash flow? Well, that’s a great question. So for me, value-add
is taking anything and making it worth more later. And so the question is always,
what will it be worth later. And I’ll tell you an
interesting story. This is back probably
five or six years ago. We had a bank from
Texas approach us. And they had taken
back a property. It was like a 200-unit
in Arlington, Texas. And they said, we like you guys. We like what you’ve done. We’ve watched your track
record in the Dallas area. So were going to actually
give me the property for free and give me the loan to fix it. So it was like $2 million
to turn it around. So now we’ll get
into that $2 million and how I came up
with that $2 million. But essentially, the
property was 60% occupied, it had all these down
units, had all this stuff. Well, what they owed on the
loan, plus the $2 million, I fast forwarded. I said, OK, what’s this property
going to be worth in two years? It wasn’t worth that. So I passed. So people will look at me
and go, I can’t believe it. Like, this bank was going
to give you the property and give you the
money to fix it. And I said, well, at
the end of the day, I was going to be into the
project close to $12 million, and in two years I
think it was only going to be worth somewhere
between $10 and $11. And so I passed. And so the point of that
story is, I always go way out. I always want to know,
what’s it going to be worth after I do the value-add? And the value-add can
come from a lot of ways. So I’ve seen people do
value-adds that cost way more than they get back. So in other words, like
how you would never do granite kitchens– and I
know we get into details here. But you would never do
granite counter tops in kitchens in a rental. But a lot of people do it. You would never do
high-end appliances and all these kinds of things. You can spend $20,000, $30,000,
$40,000 extra in anything and not getting any money back. So there’s a fine line there
on what is truly a value-add. But our typical model
is taking something that was, say, built in the
’80s, the ’90s, or 2000s that’s super dated and it’s
really, really well located. And then taking a look at
how much money should we put in there? And there’s a certain level
of rent you’re going to get. So let’s say that unit
gets a $150 more per month once it’s fully renovated. Well, you can spend $7,000
or $8,000 on a renovation, or you can spend $20,000. And from experience,
I’ve done both. And the rents are
what the rents are. There’s a cap for the tenants. So you have to go all
the way out and see, what does the market
support today, not what am I going to pioneer and make it? So luckily on those
mid-level deals that are 20, 30
years old, there’s typically new
product in the area. So you want to be
underneath the new product and above the old products,
sitting kind of somewhere in the middle. And you’re not always
exactly correct. But you’re pretty close. And so that’s what
a value-add is. So before I buy something– I’ve done this numerous times. Like the easiest explanation
is putting washers and dryers in a unit that has hookups. That’s a no-brainer. Right. The washer and dryer set costs
me $550, and I get $50 to $75, depending on the
market, more per month. So that’s a two-year payback
on just the washer and dryer. And that’s doing nothing. So you have to look at it
on that– how much money are you putting in, and when are
you going to get it back, and when does it create value? Right, because you can get about
maybe an additional 4% return on a retail flip of a
house in a $300,000 house with granite counter tops. But granite as a
rental factor is not going to increase your rent,
probably at all, right? No, no. Now, if it’s a long-term
haul, 10, 20 years, might not be a bad
play because it might be dated at some point. But the tenants
probably are not going to ruin it, where they can ruin
Formica or Corian or something like that. So yes, but that’s
exactly right. So that’s another good point. There are properties that
we bought really well that are incredible locations that I
probably will never part with. In those deals, I might put a
little more upgraded hardwood floor, for example. Or we might do upgraded
appliances or stuff like that, because I want to put something
a little more quality in– better fixtures. Because I know I’m going to hold
that thing for 10 or 15 years. But if I’m going to turn
something in two or three years, I’m essentially going to
do the very bare minimum to get the highest maximum rent. [CHUCKLES] Yeah. This is great tips. I mean, this is all
about not over-upgrading your rental properties just
because, again, it’s not a place you’re going to live. It’s not a long-term,
permanent residence. It’s a rental property. And so you have to
be really aware of– you don’t need to put
in a smart doorbell. [CHUCKLES] (CHUCKLING) Right. You don’t need to put in granite
counter tops, necessarily. You don’t need to go and put
all these bells and whistles on the property. And it’s just not going to
yield the results that you want from the cash flow. Yeah. Correct. So when you look
now at the market and you think about the
multifamily space and you see, wow, man, people are snapping
up stuff at a 2%, a 3% return, well, oh my gosh. But what about
residential real estate? Because one thing you
said to me was where you see real value right now. So if I say, hey, Ken,
right now, 2018, 2019, where do you see
the biggest value for owning rental property? You said what? Single family,
residential, which made me happy because
(CHUCKLING) that’s the bulk of what I do. Yeah. Well, first of all, if you
take a look at going way back under a couple of
different presidencies, I think it was Bush
that kind of said, hey, everybody needs to own a home. And so home-ownership
went up to, I think, 68%, 69%
of the country. Now it’s down in the low 60s. And so the reason why there’s
this big rental demand is because of that. Obviously, we had the
crisis, the housing crisis, and all those kinds of
things, which was unfortunate. And a lot of people lost things
and they moved into rentals. I get that. There’s been numerous articles
about, it’s a renter nation, it’s a renter nation,
it’s a renter nation. You just type in
Google, and you’ll see there’s a zillion
articles on this issue. And it has all very, very
good details about it. And so what’s happened
though, is believe it or not, there hasn’t been a
lot of construction because I think last year,
we delivered 480,000 units into the rental housing, into
the multifamily space, which was the most since the ’70s. But prior to that in
the last 10 years, it’s been really, really,
really, really low. So if you look at today, there’s
a valid argument that says, yes, we’ve delivered
a lot of units. And that’s true. But there’s still a huge glut. Now, you’ve got to go all
the way back to 10 years ago. And the people
are getting older. People are moving out of
their parents’ houses. They’re graduating. They’re getting jobs. They’re relocating. And so there’s this big
pressure from the last 10 years of that– just population,
employment growth, and all that kind of stuff– that the housing supply
has not met that demand. These are statistics. I would suggest your readers
go to the “Real Estate Trends Report” at ULI,
which is Urban Land Institute– great, great,
great, great, very, very lengthy report that I love to study. And it talks about
each individual market. But if you look,
there just hasn’t been a lot of single family. And so the truth is,
that even though I’m in the multifamily
space, if somebody has a choice of renting a
home with a yard and a garage, versus a two-bedroom
apartment, they’re going to take the
home and the garage if the pricing’s similar, right. Right. They just are. They just are going
to, if they have a pad or they have small
kids or whatever. They maybe have a car that they
don’t want to park in a carport or whatever. So the single-family space
has a significant advantage over multifamily in
almost every way. But you have to buy the
single families correctly, and the rents have
to make sense. Right, absolutely. So you want to be
in those spaces where you’re going to have– well, I mean, I was
going for the same thing. I’m trying to hit
that 8% to 12% return. In the same way that you’re
trying to hit that 7% to 10%, I’m trying to hit
that 8% to 12%, depending on if it’s
a C neighborhood or B neighborhood, where
my rents are going to be $700, $800, $900 a month. And maybe my all-in
price is somewhere in the $60,000, $65,000,
$70,000 range, where you have a lot of retail
buyers on those same streets, you have a lot of
blue collar jobs, you see the Target has
just moved in near. You’ve got to buy right. And that’s what we try to do. And you try to play and
look at those trends. And you’re absolutely right. The new construction
that’s out there– there’s not new construction
for the C class or B class rental population. It just doesn’t exist. That’s right. And so what you
said is exactly– so for all of our
acquisitions, we’ve tried to target
rents right at $1,000 or under because this
is workforce housing. And it’s not sexy. It’s not the class-A
beautiful stuff. It’s not your brand-new
neighborhoods or anything like that. And I just don’t
think– that’s not where the bulk of the people are. So we’ve been trying to cater
to that workforce housing. And so our target
has always been trying to keep the rents
right around $1,000. You kind of said that,
with your single families. Honestly, if you can
rent a single family for $600, $700,
$900, $1,000 a month, that’s a bargain in my opinion,
no matter where you are. And you’re going to kill
apartments and condos every single time. Yeah. And you’re right about that. I mean, what I love about
the first two properties I ever bought in the Michigan
market, I never heard a peep. I had five-year leases
on my properties. The tenants were just in there– not a peep. They loved the yard. They loved the dog
could run around the yard in the one property. And they were near decent
schools and the shopping. And because they’re in those
spaces, they have the freedom– the elbow room, I
guess you could say– in those houses that you don’t
get in an apartment, where you have people banging on the
walls and that sort of thing. So you have that
freedom in those spaces. That’s exactly right. And I think you’ve just got to
pay attention to those things, like the school districts, the
yards, all those things are incredibly important,
especially school districts. So I learned this
probably 10 years ago. We put school districts
extremely high on our list for our acquisitions
because if people can’t afford private schools, which
most can’t, the one thing– the one gift that they
can give their kids is to rent in a neighborhood
that has an incredible school. And then their kids
can go to that school. And so that’s an
indicator in my opinion. And that definitely helps
bring good families. Wonderful. Well, I’ll get you out
of here on this question on the current market, looking
at multifamilies, residential, and in the 2018,
2019 space right now. Where do you see things going? People want to talk
about a bubble. I haven’t really seen it. I don’t know. But what is your sense? You’re analyzing 600
properties last year, so you have your
pulse on the nation. Yeah. What do you see? Well, it’s interesting. I actually don’t see a bubble. But I definitely
see a slow down. We’re definitely seeing
capitalization rates go really, really low. As you know, I’m in the process
of selling a little over $200 million worth of property. And our cap rates are
settling in in the mid-4’s, which is really, really low. But there’s so much capital
in the market trying to find a home, that,
like I said, we talked about in the
beginning, is people are still buying because
they’re preserving capital. And yeah, I got into an
interesting discussion. We were bidding
on a big property in Scottsdale, Arizona. And I ended up meeting
with a $6 billion equity group that
was also bidding on it for a different reason. And I said, hey, are you
bidding on this property? They said like, yeah, yeah. And I said, well, what do you
think about the exit cap rate? Which is the sale piece. Because there’s always
an entry cap rate, and there’s an exit cap rate. You buy a one cap rate,
and you sell at another. And I said, if you’re
buying it at 3 and 1/2, what are you going to do? Right. And he’s like, yeah. He’s like, we’re very
aware of that issue. And he said, we’re
bidding on it anyway. So I said, all your
value-add that you do– and it was like
a very big value, like a $35 million
value-add, because it was– Wow. –a big project– could
be wiped out with 1 to 1 and 1/2 point
increase in cap rate. And so basically
what he was telling me was, they have so
much cash, they just want to buy this thing and then
hope the cap rate stays low. And as you know, hope is
[CHUCKLES] not a good strategy. (CHUCKLING) Right. Right. But that’s what the
big guys are doing. Yeah, that’s amazing. That’s amazing. Yeah, I don’t see
a bubble either, but people love
to write about it. And people love to write
about it in the news because it’s a good click bait. Yeah. It is. Get’s you to click. Well, Ken, thank you
so much for joining us. Where can people learn more
about everything you’re working on right now, man? Great, thank you. Yeah, well MC Companies,
that’s our organization. You go there. And we have a lot of great
stuff going on– philanthropy and you can talk about
some of the stuff we’re doing on the
property management side. And then– I do individual
videos, of course, on property management and
entrepreneurship and debt and equity and things like that. So either one is a
great, great start. Awesome. And Ken’s going to
be back on the show because we’re going to
be talking about property management and
partnerships and things, and when you get a
contractor that goes sour, how to handle all that. No one has more experience
in this than Ken does. (LAUGHING) Yeah. Happened a lot. Happened a lot with me. (LAUGHING) Yeah. Yeah. So Ken will be back on the show. Great to have you
here, Ken, as always. And thanks to all of you for
downloading and subscribing to the show. We really appreciate it. If you haven’t taken
action yet, just come on over to our website, download
our free cheat sheet. It’s our Freedom
Number Cheat Sheet. It’s totally free. It’s three pages. It lets you figure out what
is the number that it would take for you to achieve
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your freedom number is. Thank you so much. We’ll see you back
here next time on the Investing in
Real Estate Show. Now, go out there, take action,
and become a real estate investor. Get off the couch. We’ll see you next
time, everyone.

52 thoughts on “Multifamily Investments Don’t Make Sense Right Now with Ken McElroy

  • I think there is undoubtedly a bubble, it's a fact just looking at the inflation adjusted median sale price of homes. But there's still opportunity out there

  • Clayton do u have any videos on adus ? Have u done any ? I just aquired a 4/2 1500 which will make about $200 cash flow. But gonna convert a newer construction stand alone 750 sq ft garage into a 1 or 2 bedroom apartment for $1000 total cash flow. Have you any experience in this ?

  • SFR scale is problematic. Management obviously more difficult given dispersed locations. Renovation costs suffer from scale as well.
    Acquisition of work force multi-family to preserve capital seems a bit odd for large funds. If that is the case then there is excessive capital feeding this market which cannot end well. I have seen acquisition
    side of large funds bid down to a 2 cap rate anticipating rising rents for A or better properties in primary markets.
    Interesting that Mr. McElroy mentioned a 60% occupancy rate for the underperforming property offered
    to him in Arlington, Texas. Special servicers or lending institutions seem prepared to hang on until 60% occupancy is reached then it is time to deal. Point is always look to 60% occupancy as most opportune
    for buyers leverage, which others will know as well. Probably wise to pass on the project at the numbers read between the lines 50,000 per unit plus 10,000 in renovation costs. Wasn’t there but perhaps undercutting the quoted 50,000 substantially and borrowing the acquisition and renovation
    costs elsewhere was possible. 10,000 per unit does cover a substantial renovation. I have participated
    in complete exterior renovations of roof, gutters, general carpentry, complete residing, stair and rail repairs, new windows with complete exterior paint for 3,000 to 3,500 per unit. The 7,000 or 6,500 goes to grounds, pool, clubhouse with monies left for interior updates depending on work assigned to operations. Real-Estate is a wonderful investment vehicle. Enjoy your day.

  • Great content, loved this video, definitely gave me a different perspective and was interesting to hear someone give a different view than Uncle GC “Grant Cardone” that actually made sense

  • Great discusssion. Always good to hear from those who have been investing, holding, and simply transacting in real estate for many years.

  • I now know the importance of motivation between Wall Street $$$ and a private operator as myself. It also makes me see syndicators in a whole new light. And I learned a new word – "Workforce Housing". COOL!!!

  • nope. Bill Clinton the pedophile was the one who said every American needs home, relaxed the regulations and the housing bubble started….

  • This was a very good interview.

    I wonder why so many investors go through the deal analysis process, and then not make an offer? The only thing money can't fix is location. Ken said he only made offers on 10% of the properties his team analyzed (60 out of 600). Why do you think he doesn't just adjust his offer price until the deal makes sense and then make an offer?

    Thank you again, Kevin Grail

  • Hedge funds think it's a wise business strategy to buy real estate at a 4 cap rate? So real estate is now risk free? I'd say we are living in "interesting times.

  • Thank you for your insights Ken and I agree that it is becoming more challenging. There are still great deals in multifamily right now but you just have to work harder with more offers. I still want my money in multifamily vs stocks or SFH right now.

  • ###. Great. Show Clayton I definitely see you point. However I think it's worth mentioning that. There is multi family , say two, 3, and 4 units. And then there's mega multi family. Where Ken deal s. I'm currently on my second 4plex. With very strong noi s. Both. Properties are in work force areas. Finally, with. Single family or multi family. Failure is. The eniblity to do the nessinary work and planning. Before purchasing a property.

  • It depends where Ken is talking about. AZ maybe tapped out.

    I just underwrote properties that went Loi yesterday that cash flowed 7% to 10%.

    Everyone please read David Lindahl Emerging Markets.

  • We are blessed here in Baltimore. If you know the city, you can find class C homes all in for 50-70k and rent them from $1200-1500/month

  • All i got out of this, is in 10-15 years from now, there will be tons of mismanaged apartment buildings hitting the market. Let's be honest, if you are an institutional investor that knows nothing about real-estate and are making decisions based on a 25 year old analysts who also knows nothing about real estate, your investment will only sit for so long before it needs massive re-investment and by that time, these investors will want to bail and the cycle will start again. i will stock to the small deals and when that day comes, I hope I will be ready to buy these big deals.

  • Very interesting…

    He and his guys have (had?) an acquisition team that crisscrosses(d?) the country looking for properties to buy. Must be nice to have had people (his "acquisition guy!!") like that doing all that legwork for you.

    They (not he) looked at 600 deals. 600 deals. Next question is where these deals were. But the most important question is where THAT DEAL IS out of 600 where the numbers actually worked?? What attracted their attention to the properties they looked at? What about those of us who have extremely limited resources and don't have a big, fancy "acquisition team" to go out and scour the whole of the good ol' U S of A?

  • I enjoy listening to this speaker… very helpful information as I make my first purchase of multifamily property

  • Not every tenant wants a cookie cutter rental with basic/cheap finishes. A higher finish will help to attract and keep tenants with a different mind set. Some will even pay more…You are competing against other rentals. You are still selling a product.

  • Is he referencing 2-4 family units or 50-200+?

    How do ppl profit from a 1031 tax code, more so does one not pay themselves or invest all profits from rents / selling from real estate year over year, without actually putting that money in ones’pocket?

    Is the rate of return in today’s market worth investing in a 2-4 family unit?

  • Seeing this trend on the Mainline in Montgomery country PA… too many single homes, with ppl earning 80k-120k as a first job on average. Young Ppl want to live in a home( not unless it’s in the inner city) , yet their knowledge of what caused the housing crisis is very limited so ppl choose to rent and job mobility as well

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